A Bad Time to Return to Rubinomics?

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Democratic candidates have been running as fiscal hawks this election season, lambasting Republicans as a bunch of free spenders who mismanaged the Clinton surpluses into the Bush deficits. It seems as if they are arguing for a return to Rubinomics, the economic theory named after President Clinton's second treasury secretary, Robert Rubin.

Rubinomics holds that high budget deficits cause bond traders to bid up long-term interest rates over fears of deficit-induced inflation. If budgets are balanced, so the theory goes, rates will come down. That, in turn, will boost economic growth. Now there are two possible problems here:

  • It's not at all clear that Rubinomics itself was the prime mover behind the 1990s economic boom. After all, once the newly minted Clinton administration committed itself to taming the budget deficit, rates didn't fall for very long. When Clinton signed his tax-increasing budget on Aug. 10, 1993, the yield on the 30-year bond traded was 6.45 percent. It then fell to 5.78 percent by October 15. So far, so good. But then rates started to slowly rise. They were back to 6.45 percent by Feb. 15, 2004. They finally peaked at 8.18 percent on Nov. 7, 1994, the day before the 1994 midterm elections, when the GOP won control of the House and Senate. Only then did rates begin a descent from a level to which they have not since returned.
  • If you are worried that the deflating housing bubble will push the U.S. economy into recession, now may not be the time a for a massive dose of fiscal prudence, at least if you want strong economic growth. In a recent research note to clients, Merrill Lynch economist David Rosenberg–who frets mightily about the housing bust–wrote that if "the government moves towards deficit reduction (as the Democrats are campaigning on), then we think the implications are … sluggish domestic demand growth (bad for consumer cyclicals) … [and] disinflation pressure (good for bonds)."
  • In short, a sluggish economy where business holds on to its cash, people save a bit more, and inflation is falling. Great for the so-called bond market vigilantes–but bad for the stock market sheriffs and Main Street.

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